- The Bloomberg Global Aggregate index has delivered a 4.07% return year-to-date, compared to a 16.25% fall in 2022.
- Underpinning the shift in sentiment is the expectation that, despite recent hawkish statements, leading central banks will ease up on rate rises this year as inflation falls.
Fixed income markets have made a positive start to the year, boosted by the growing expectation that inflation has peaked in the US and Europe, encouraging central banks to ease the pace of rate hikes.
The asset class endured a bruising sell-off last year as central banks responded to runaway inflation by aggressively ramping up rates. But as monetary authorities adjust policy as inflation cools and looming recession risk takes the shine off equities, higher-rated credit – as well as corporate hybrids, subordinated and structured debt – is seeing reinvigorated interest from investors.
The Bloomberg Global Aggregate index has delivered a 4.07% return this year as at 18 January, compared to a 16.25% fall in 20221.
Figure 1: The Bloomberg Global Aggregate bond index
“Our expectations for credit markets this year are constructive as forward-looking risk factors appear more balanced,” says Fraser Lundie, Head of Fixed Income – Public Markets, Federated Hermes Limited.
Underpinning the shift in sentiment is the expectation that, despite recent hawkish statements, the US Federal Reserve and European Central Bank will ease up on rate rises this year as inflation drops.
“Central banks are approaching the end of their tightening mode, with inflation and policy rates close to, or at their peaks. As such, after a year of rising interest rates, corporate spreads and yields are attractive and bond prices are low, opening up a range of opportunities for investors,” Lundie adds.
The 10-year US treasury yield has fallen to 3.39% at 14:00 GMT on 19 January, compared to 3.87% at the end of 2022, while Germany’s 10-year government bond yield has fallen to 2.04% from 2.2%.
US inflation declined for a sixth consecutive month in December, posting one-year increase of 6.0%, the lowest level since October 20212. The 12-month inflation figure in the eurozone fell to 9.2% in December, down from 10.1% in November on the back of lower energy prices3.
The latest inflation data has added to expectations that the Fed will increase rates by just 25bps in February, following a 50bps hike in December.
Another factor behind the global bond rally is the fear of recession in many countries, which could dilute the appeal of riskier equities and make the steady returns promised by higher-rated debt more attractive.
The US benchmark S&P 500 closed down 1.56% on Wednesday while the regional Stoxx Europe 50 index fell 1.92% on Thursday after weak US retail data added to fears about slowing economic growth4.
Corporate spreads and yields are attractive and bond prices are low
While many developed countries are forecast to enter recession in 2023, most leading emerging economies are expected to prove more resilient. Emerging market governments have reportedly raised more than US$40bn on international bond markets so far this year5.
The JPMorgan Emerging Market Bond Index (EMBI) was up 3.62% as on 18 January after falling 16.45% last year6.
“It’s been a good start to the year in the world of emerging markets fixed income, largely fuelled by crossover investors seeking to capitalise and lock-in emerging market sovereigns and corporates higher yield profile,” says Mohammed Elmi, Portfolio Manager, Emerging Markets Fixed Income at Federated Hermes.
The reopening of China’s economy — a vital growth engine — as strict Covid-19 restrictions are lifted has added to the sense of optimism.
“The China re-opening story and the likely impact that will have across the emerging world, as well as the weakening dollar and the possible step change in the US Federal Reserve’s hiking cycle have also contributed to the buoyant tone,” Elmi adds.
For further analysis on how inflation might play out this year, please see Spectrum, Q4 2022: Inflation, one year on
1 Bloomberg as at 19 January
2 US inflation falls to lowest level in more than a year | Financial Times (ft.com)
3 Eurozone inflation returns to single figures in sharper than expected fall | Financial Times (ft.com)
4 Bloomberg as at 19 January
5 Emerging market governments raise $40bn in January borrowing binge | Financial Times (ft.com)
6 Bloomberg as at 19 January